Here's Why Shenzhen Techwinsemi Technology (SZSE:001309) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shenzhen Techwinsemi Technology Co., Ltd. (SZSE:001309) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shenzhen Techwinsemi Technology

How Much Debt Does Shenzhen Techwinsemi Technology Carry?

As you can see below, at the end of March 2024, Shenzhen Techwinsemi Technology had CN¥1.79b of debt, up from CN¥441.7m a year ago. Click the image for more detail. However, it does have CN¥204.7m in cash offsetting this, leading to net debt of about CN¥1.58b.

How Strong Is Shenzhen Techwinsemi Technology's Balance Sheet?

According to the last reported balance sheet, Shenzhen Techwinsemi Technology had liabilities of CN¥2.25b due within 12 months, and liabilities of CN¥249.7m due beyond 12 months. Offsetting this, it had CN¥204.7m in cash and CN¥257.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.04b more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Techwinsemi Technology shares are worth a total of CN¥12.1b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 4.9 Shenzhen Techwinsemi Technology has a fairly noticeable amount of debt. But the high interest coverage of 8.6 suggests it can easily service that debt. Notably, Shenzhen Techwinsemi Technology made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥313m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shenzhen Techwinsemi Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Shenzhen Techwinsemi Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Shenzhen Techwinsemi Technology's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. Taking the abovementioned factors together we do think Shenzhen Techwinsemi Technology's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shenzhen Techwinsemi Technology is showing 3 warning signs in our investment analysis , and 2 of those are a bit concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.